In less than 2 months after the December meeting of the Organization of Petroleum Exporting Countries, the global balance between crude supply and demand tightened to the point where it was unnecessary for the group to adjust production at its Jan. 30 meeting, as some earlier predicted.
Unlike the December meeting at which OPEC ministers agreed to eliminate overproduction, the market balance by the end of January "had moved very significantly in their favor," said Paul Horsnell of Barclays Capital Inc., London. Otherwise, he said, the ministers would have had to make "a sizable output cut merely to establish the same position that they are in now without having had to cut."
'Dichotomy' in outlooks
Back in December, there was "a clear dichotomy in views of the global oil market," Horsnell said. More bearish individual projections by the International Energy Agency and the OPEC Secretariat "implied that there would be significant global inventory builds over the coming quarters unless OPEC throttled back on output." However, separate and more bullish estimates by Barclays Capital and the US Department of Energy "suggested that OPEC had about 2 million b/d more margin of error to play with," said Horsnell. "That gap has yet to be fully resolved, but it has narrowed."
He said, "The more bullish forecasts have survived the flow of the extra 7 weeks of [market] data fairly robustly." Barclays Capital's latest estimate of the call on OPEC crude is lower by 100,000 b/d for the fourth quarter of 2004 but unchanged for the first and second quarters of 2005. DOE's current forecast is lower by 100,000 b/d for the final quarter of 2004, down by 300,000 b/d for the first quarter of 2005, and unchanged for the second quarter.
On the other hand, the OPEC Secretariat revised its estimate up by 900,000 b/d for the final quarter of 2004, by 700,000 b/d for the first quarter of 2005, and by 800,000 b/d for the second quarter. IEA pushed up its estimates by 700,000 b/d for the fourth quarter of 2004, 600,000 b/d for the first quarter of 2005, by 300,000 b/d for the second quarter.
"Put another way, the changes in the OPEC Secretariat numbers gave ministers the appearance of an extra 800,000 b/d to play with, compared [with] what they thought they had before," Horsnell said. "With some 40% of the disparity between estimates already resolved, and almost entirely in OPEC's favor, one can see why ministers would be happy to go with the strong momentum in the [market] data and to leave taking actions until such a point as they felt that the momentum might ebb."
Possible $40/bbl 'floor'
The last time the near-month contract for benchmark US light, sweet crudes traded below $40/bbl on the New York Mercantile Exchange was on July 13, 2004. OPEC's decision at the Jan. 30 meeting to maintain production at 27 million b/d while temporarily abandoning a target price band was "further confirmation, if it were needed," that $40/bbl "is now more of a floor to [crude] prices rather than a cap," said Horsnell.
To drive crude prices below $40/bbl "for any significant period would need a significant body of opinion to conclude that OPEC was being too lax with output and had misread the global balances," he said.
However, Horsnell claimed, "The greater danger is that OPEC will not be lax enough. Even if a short-term drive back through $40 succeeded, OPEC does seem to have more than enough ammunition at its disposal to rectify matters. In all, we continue to see the potential outcomes as being highly skewed, with the downside better protected than the upside, even before one adds in some of the current and evolving international policy."
Consensus too low
A Feb. 7 report from the Houston office of Raymond James & Associates Inc. noted the "recent propensity" of Wall Street consensus forecasts of crude and natural gas prices to be too low and offered two plausible explanations:
·Excessive conservatism. "Some analysts seem to be putting out forecasts that represent a 'floor' for where they believe that prices will go rather than their 'best guess,' said Raymond James. When such conservatism becomes excessive, it can lead to unreasonably low forecasts.
·Regression to the mean. Some analysts believe energy prices must inevitably revert back to historical averages. But energy prices are set by market fundamentals, not a statistically random process. And current fundamentals "are greatly different from those that prevailed through most of the 1990s," said Raymond James.
(Online Feb. 8, 2005; author's e-mail: firstname.lastname@example.org)